Banks have aided in environmental devastation through their financing activities that allow big corporations to continue to harm the environment. Environmental disasters have given birth to Credit Default Swaps which allow banks to take risk of their books and make great profits.
The Problem:
Banks lend to companies aiding the capitalistic economy which runs on consumption. Companies use the money to make productions and continue consumption going, and these companies harm the environment. Banks package the debts of companies and resell them which leads to further economic devastation. When the economy collapses, the government runs on the Keynesian philosophy which is basically just trying to get an economy up and running again by spending. This continues to put stress on our natural ecosystems as it boosts consumption which exacerbates environmental devastation (Pentzlin).
Not only do banks contribute to the environmental harm through their lending, but they aid in devastating capitalism which in itself is currently unsustainable. We are all stakeholders in this. We as individuals take out loans, buy corporate products, and so on. Corporations take out loans from banks and use business practices that degrade our environment. Governments let these practices go on and bailout banks and big business while our natural resources are depleted and our world is being destroyed.
A specific example of bank lending practices I would like to focus on is toxic assets, particularly Credit Default Swaps.
Who knew that the environment was so tied in with our financial collapse? I definitely didn’t, but the Huffington Post really brought to light a form of risky investments I had no idea were directly tied to the environment. After the Exxon Valdez spill in 1989, Exxon needed to find a way to be able to pay its $5 billion in compensatory damages. This was reduced later to only $500 million. Exxon decided to turn to its trusted partner, J.P. Morgan. The bank extended a line of credit to the oil giant worth $4.8 billion. Here we saw the birth of a Credit Default Swap. J.P. Morgan wanted to keep Exxon as a client and still be off the hook if Exxon defaulted. The best solution to this was the Credit Default Swap (CDS). In return for giving this risky loan, J.P. Morgan would receive a handsome cut. The bank took this loan obligation and packaged it with other loans that were safer and were unlikely to default to mask the risk of the Exxon debt. Packaging these different levels of risks is known as tranching. J.P. Morgan then resold these CDS as if they were securities. In turn, the bank would get insurance against its loans, and receive great profits from investors. This marked a new era of banking where banks would be able to take risk off the books and generate great profits while still having plenty of money left over to lend to other clients. Goldman Sachs took advantage of these debt instruments and sold them to investors, and when they realized the financial collapse was near they bet against the clients they sold them to bringing in record profits. Meanwhile AIG, Lehman Brothers, and others were not so lucky and had to pay out huge sums of money to investors whom were insured. Lehman was unable to payout and bankrupted (Linkins).
Implications:
Banks are pivotal in allocating financial resources in our global world. Whether they are providing financial services to governments or corporations, banks are involved in almost every segment of human activity. By providing these financial services to corporations and governments, banks therefore are part of the matrix of environmental sustainability. They finance activities that are harmful to the environment.
Thanks to J.P. Morgan, Exxon continues to survive and has recorded profits of $295 billion from 2001-2009 and $6 billion just in the first quarter of 2010 ("Climate Progress"). Meanwhile, the implications are dire. In 1989, Exxon spilled 42 million liters of crude oil and contaminated 1,990 kilometers of the shoreline of Alaska. Over 250,000 seabirds died, 2,000 sea otters, and other species of animals days after the spill. It will take 30 years for the area to fully recover. Meanwhile, Exxon continues to operate and destroy the environment thanks to being “bailed out” (Graham).
The BP spill has been an even bigger environmental devastation. Over 185 million gallons of crude oil were released in the Gulf, and the environmental effects are still rather unknown. Over 400 species of turtles and 34,000 birds are at risk of dying (Wilson).
BP just like Exxon has a lot of debt outstanding, currently over $20 billion. A lot of this debt is in the form of CDS. If BP went bankrupt, investors in the CDS would incur huge losses as its CDS are in 18% of all global Moody rated CDS (Durden).
Future risks of financial chaos are likely since over $63 trillion of these debt securities are out in the market. This is approximately 4 times the size of our U.S. economy (Gilani).
The Sierra Club and the Rainforest Action Network estimates that nine banks lent money in excess of $4 billion to corporations like Massey Energy participating in mountaintop removal mining through loans and debt instruments since 2008 (Zeller).
Banks tend to ignore sustainability risks of the corporations they do business with since these risks are outside of the bank and do not directly affect the institution. These practices in themselves affect the financial stability of the world economy and as seen with our recession, current banking practices are far from sustainable for the long term future. The probability of default increases when a company has poor operational practices. Ignoring risks of environmental sustainability can lead to increases in raw material prices, environmental devastation, reputational damage of the bank, loss of customers, litigation, and of course default of the corporation (Pentzlin). Risk management processes need to be improved, so that the global financial system can be strengthened. In a world with a growing population and limited resources, Banks cannot continue these risky processes which contribute to the destruction of the environment and the undermining of sustainable developmental practices.
The Solution:
The financial world can stand up and practice more financially and economically sustainable practices. According to the Huffington Post, companies such as Wells Fargo, Credit Suisse, and HSBC are looking more into the practices of the business and corporations they help support such as companies involved in mountaintop removal. HSBC has seemed to make the most strides here by totally ending its relationship with producers of palm oil that aid in the deforestation of the developing world . Not lending to these companies is certainly a viable option (Cohen).
Other options include excluding predatory loans, non-toxic assets, and abandoning work with corrupt regimes. None of these elements are needed to produce profits. Banks could also encourage corporate responsibility efforts and make sure their supply chain base is striving to be green. The financial world could also make it a priority to invest in sectors of the economy that deliver sustainable initiatives in economics, socially, and in the environment (Murray).
The most important element in ensuring the viability of the financial system as a whole and the environment is the risk management decision process. Studies done by ETH Zurich and GOE show that in their findings, incorporating sustainability criteria in risk management decisions improved risk classification from 78.9 to 86.6% and reduced incorrect predictions by 22.7% in German banks. Currently, banking is based on environmental financial risk in present terms and the present value of the banks’ investments. Essentially, banks face three environmental risks that include direct, indirect, and reputational risks. A direct risk could be if the bank owns a loan on a land asset and the borrower defaults due to polluting and contamination activities. The bank could be held responsible financially for this disaster and face legal consequences. A reputational risk is simply just a damaged public view of the bank due to media stories and so on. Indirect risks are often credit risks where the bank loses their investment since the borrower cannot repay the loan (Thompson).
The correlation between sustainability and the probability of default can be strong especially in the American subprime mortgage case. Since synthetic collateralized debt obligations (CDOs) came packaged with other more safe assets and debts, the probability of default was much higher than initially projected. This passed the probability of default to other parts of the financial system while minimizing the direct impact on the initial financer. This undermined the financial system and its sustainability. Ultimately, these practices cannot go on due to them spreading through every part of the economy. While these solutions might not directly aid in environmental sustainability, they can deter companies from practicing unsustainable practices or perhaps invest in more sustainable practices. As the world’s population is growing, and as we are reaching the limits of our natural world; financial institutions cannot continue these risky practices that will destabilize society (Thompson).
Friends of the Earth Europe’s environmental campaigns and some background information on corporate environmental damage and the need for environmental accountability: http://www.foeeurope.org/corporates/Index.htm
Wall Street: Money Never Sleeps- A good movie for entertainment and information on unsustainable banking practices and their impact http://www.imdb.com/title/tt1027718/
Thompson, Paul, and Christopher J. Cowton. "Bringing the environment into bank lending: implications for environmental reporting." British Accounting Review 36.2 (2004): 197-218. Business Source Premier. EBSCO. Web. 19 Oct. 2010.
Zeller, Tom. "Banks Grow Wary of Environmental Risks." New York Times 30 Aug 2010: n. pag. Web. 21 Oct 2010. <http:/www.nytimes.com/2010/08/31/business/energy-environment/31coal.html?_r=1>.
Banks have aided in environmental devastation through their financing activities that allow big corporations to continue to harm the environment. Environmental disasters have given birth to Credit Default Swaps which allow banks to take risk of their books and make great profits.
The Problem:
Banks lend to companies aiding the capitalistic economy which runs on consumption. Companies use the money to make productions and continue consumption going, and these companies harm the environment. Banks package the debts of companies and resell them which leads to further economic devastation. When the economy collapses, the government runs on the Keynesian philosophy which is basically just trying to get an economy up and running again by spending. This continues to put stress on our natural ecosystems as it boosts consumption which exacerbates environmental devastation (Pentzlin).
Not only do banks contribute to the environmental harm through their lending, but they aid in devastating capitalism which in itself is currently unsustainable. We are all stakeholders in this. We as individuals take out loans, buy corporate products, and so on. Corporations take out loans from banks and use business practices that degrade our environment. Governments let these practices go on and bailout banks and big business while our natural resources are depleted and our world is being destroyed.
A specific example of bank lending practices I would like to focus on is toxic assets, particularly Credit Default Swaps.
Who knew that the environment was so tied in with our financial collapse? I definitely didn’t, but the Huffington Post really brought to light a form of risky investments I had no idea were directly tied to the environment. After the Exxon Valdez spill in 1989, Exxon needed to find a way to be able to pay its $5 billion in compensatory damages. This was reduced later to only $500 million. Exxon decided to turn to its trusted partner, J.P. Morgan. The bank extended a line of credit to the oil giant worth $4.8 billion. Here we saw the birth of a Credit Default Swap. J.P. Morgan wanted to keep Exxon as a client and still be off the hook if Exxon defaulted. The best solution to this was the Credit Default Swap (CDS). In return for giving this risky loan, J.P. Morgan would receive a handsome cut. The bank took this loan obligation and packaged it with other loans that were safer and were unlikely to default to mask the risk of the Exxon debt. Packaging these different levels of risks is known as tranching. J.P. Morgan then resold these CDS as if they were securities. In turn, the bank would get insurance against its loans, and receive great profits from investors. This marked a new era of banking where banks would be able to take risk off the books and generate great profits while still having plenty of money left over to lend to other clients. Goldman Sachs took advantage of these debt instruments and sold them to investors, and when they realized the financial collapse was near they bet against the clients they sold them to bringing in record profits. Meanwhile AIG, Lehman Brothers, and others were not so lucky and had to pay out huge sums of money to investors whom were insured. Lehman was unable to payout and bankrupted (Linkins).
Implications:
Banks are pivotal in allocating financial resources in our global world. Whether they are providing financial services to governments or corporations, banks are involved in almost every segment of human activity. By providing these financial services to corporations and governments, banks therefore are part of the matrix of environmental sustainability. They finance activities that are harmful to the environment.
Thanks to J.P. Morgan, Exxon continues to survive and has recorded profits of $295 billion from 2001-2009 and $6 billion just in the first quarter of 2010 ("Climate Progress"). Meanwhile, the implications are dire. In 1989, Exxon spilled 42 million liters of crude oil and contaminated 1,990 kilometers of the shoreline of Alaska. Over 250,000 seabirds died, 2,000 sea otters, and other species of animals days after the spill. It will take 30 years for the area to fully recover. Meanwhile, Exxon continues to operate and destroy the environment thanks to being “bailed out” (Graham).
The BP spill has been an even bigger environmental devastation. Over 185 million gallons of crude oil were released in the Gulf, and the environmental effects are still rather unknown. Over 400 species of turtles and 34,000 birds are at risk of dying (Wilson).
BP just like Exxon has a lot of debt outstanding, currently over $20 billion. A lot of this debt is in the form of CDS. If BP went bankrupt, investors in the CDS would incur huge losses as its CDS are in 18% of all global Moody rated CDS (Durden).
Future risks of financial chaos are likely since over $63 trillion of these debt securities are out in the market. This is approximately 4 times the size of our U.S. economy (Gilani).
The Sierra Club and the Rainforest Action Network estimates that nine banks lent money in excess of $4 billion to corporations like Massey Energy participating in mountaintop removal mining through loans and debt instruments since 2008 (Zeller).
Banks tend to ignore sustainability risks of the corporations they do business with since these risks are outside of the bank and do not directly affect the institution. These practices in themselves affect the financial stability of the world economy and as seen with our recession, current banking practices are far from sustainable for the long term future. The probability of default increases when a company has poor operational practices. Ignoring risks of environmental sustainability can lead to increases in raw material prices, environmental devastation, reputational damage of the bank, loss of customers, litigation, and of course default of the corporation (Pentzlin). Risk management processes need to be improved, so that the global financial system can be strengthened. In a world with a growing population and limited resources, Banks cannot continue these risky processes which contribute to the destruction of the environment and the undermining of sustainable developmental practices.
The Solution:
The financial world can stand up and practice more financially and economically sustainable practices. According to the Huffington Post, companies such as Wells Fargo, Credit Suisse, and HSBC are looking more into the practices of the business and corporations they help support such as companies involved in mountaintop removal. HSBC has seemed to make the most strides here by totally ending its relationship with producers of palm oil that aid in the deforestation of the developing world . Not lending to these companies is certainly a viable option (Cohen).
Other options include excluding predatory loans, non-toxic assets, and abandoning work with corrupt regimes. None of these elements are needed to produce profits. Banks could also encourage corporate responsibility efforts and make sure their supply chain base is striving to be green. The financial world could also make it a priority to invest in sectors of the economy that deliver sustainable initiatives in economics, socially, and in the environment (Murray).
The most important element in ensuring the viability of the financial system as a whole and the environment is the risk management decision process. Studies done by ETH Zurich and GOE show that in their findings, incorporating sustainability criteria in risk management decisions improved risk classification from 78.9 to 86.6% and reduced incorrect predictions by 22.7% in German banks. Currently, banking is based on environmental financial risk in present terms and the present value of the banks’ investments. Essentially, banks face three environmental risks that include direct, indirect, and reputational risks. A direct risk could be if the bank owns a loan on a land asset and the borrower defaults due to polluting and contamination activities. The bank could be held responsible financially for this disaster and face legal consequences. A reputational risk is simply just a damaged public view of the bank due to media stories and so on. Indirect risks are often credit risks where the bank loses their investment since the borrower cannot repay the loan (Thompson).
The correlation between sustainability and the probability of default can be strong especially in the American subprime mortgage case. Since synthetic collateralized debt obligations (CDOs) came packaged with other more safe assets and debts, the probability of default was much higher than initially projected. This passed the probability of default to other parts of the financial system while minimizing the direct impact on the initial financer. This undermined the financial system and its sustainability. Ultimately, these practices cannot go on due to them spreading through every part of the economy. While these solutions might not directly aid in environmental sustainability, they can deter companies from practicing unsustainable practices or perhaps invest in more sustainable practices. As the world’s population is growing, and as we are reaching the limits of our natural world; financial institutions cannot continue these risky practices that will destabilize society (Thompson).
Links:
Funny, but yet informative YouTube video on Keynesian Economics:
http://www.youtube.com/watch?v=d0nERTFo-Sk
Friends of the Earth Europe’s environmental campaigns and some background information on corporate environmental damage and the need for environmental accountability:
http://www.foeeurope.org/corporates/Index.htm
Anything you have ever wanted to know about Credit Default Swaps:
http://en.wikipedia.org/wiki/Credit_default_swap
The South East Asian Central Bank Research and Training Centre perspective on using central banks as change agents for environmental sustainability:
http://www.seacen.org/GUI/pdf/publications/staff_paper/2010/SP76.pdf
Wall Street: Money Never Sleeps- A good movie for entertainment and information on unsustainable banking practices and their impact
http://www.imdb.com/title/tt1027718/
Information on the Sub-prime Mortgage Crisis:
http://en.wikipedia.org/wiki/Subprime_mortgage_crisis
The Dodd-Frank Wall Street Bill- An attempt to prevent a future financial crisis
http://en.wikipedia.org/wiki/Dodd%E2%80%93Frank_Wall_Street_Reform_and_Consumer_Protection_Act
Images:
Wall Street Sign: http://staplessoccer.wordpress.com/2010/01/31/staples-soccer-players-seek-summer-jobs/
Gordon Gekko: http://www.huffingtonpost.com/andy-ostroy/goldman-announces-record_b_233082.html
Exxon: http://www.corpapp.com/blog/2010/01/iraq-exxon-to-sign-w-qurna-deal-on-jan-25/
BP: http://indolinkenglish.wordpress.com/2009/08/31/bp-sends-1-5bn-deal-to-india/
Handshake: http://www.thecasualtruth.com/story/what-are-credit-default-swaps
Bio Hazard: http://i599.photobucket.com/albums/tt77/melaina_photos/biohazard.png
Money Flood: http://financialendtimes.wordpress.com/defaults/
Dead Birds: http://www.getmoneyenergy.com/2010/05/effects-bp-oil-spill-economy-stocks-deepwater/
Explosion: http://www.bnet.com/blog/clean-energy/gulf-oil-spill-putting-an-end-to-the-big-oil-bailout/1734
References:
Cohen, Steven. "The Transition to Sustainability Management Is Finally Underway." Huffington Post 01 Sep 2010: n. pag. Web. 20 Oct 2010. <http://www.huffingtonpost.com/steven-cohen/the-transition-to-sustain_b_702457.html>.
Durden, Tyler. "BP's Bankruptcy Would Impair 117 (18% Of Total) Collateralized Synthetic Obligations, Lead To Pervasive Losses." Zero Hedge 21 June 2010: n. pag. Web. 19 Oct 2010. <http://www.zerohedge.com/article/bps-bankruptcy-would-impair-117-18-total-collateralized-synthetic-obligations-lead-pervasive>.
Gilani, Shah. "The Real Reason for the Global Financial Crisis…the Story No One's Talking About." Money Morning 18 Sep 2008: n. pag. Web. 20 Oct 2010. <http://moneymorning.com/2008/09/18/credit-default-swaps/>.
Graham, Sarah. "Environmental Effects of Exxon Valdez Spill Still Being Felt." Scientific American 19 Dec 2003: n. pag. Web. 19 Oct 2010. <http://www.scientificamerican.com/article.cfm?id=environmental-effects-of>.
"JP Morgan invented credit-default swaps to give Exxon credit line for Valdez liability." Climate Progress. Center for American Progress Fund, 26 May 2010. Web. 19 Oct 2010. <http://climateprogress.org/2010/05/26/jp-morgan-invented-credit-default-swaps-to-give-exxon-credit-line-for-valdez-liability/>.
Linkins, Jason. "Exxon Valdez: How That Disaster Destroyed The Economy 20 Years Later." Huffington Post 08 Aug 2010: n. pag. Web. 18 Oct 2010. <http://www.huffingtonpost.com/2010/06/08/exxon-valdez-how-that-dis_n_605080.html>.
Murray, James. "Banks, computer rage, and the future of sustainable finance." Business Green 08 June 2010: n. pag. Web. 19 Oct 2010. <http://www.businessgreen.com/business-green/news/2264371/banks-computer-rage-future>.
Pentzlin, Daniel. "Submission to the EU Capital Requirements Directive Consultation." Friends of the Earth Europe, 26 Feb 2010. Web. 18 Oct 2010. <http://www.foeeurope.org/corporates/bankingregulation/submission-to-CRD-IV-consultation-FoEE.pdf>.
Thompson, Paul, and Christopher J. Cowton. "Bringing the environment into bank lending: implications for environmental reporting." British Accounting Review 36.2 (2004): 197-218. Business Source Premier. EBSCO. Web. 19 Oct. 2010.
Wilson, Elizabeth. "Oil Spill's Size Swells." Chemical & Engineering News 27 Sep 2010: n. pag. Web. 20 Oct 2010. <http://pubs.acs.org/cen/news/88/i39/8839notw7.html>.
Zeller, Tom. "Banks Grow Wary of Environmental Risks." New York Times 30 Aug 2010: n. pag. Web. 21 Oct 2010. <http:/www.nytimes.com/2010/08/31/business/energy-environment/31coal.html?_r=1>.